NY futures continued to move higher during this holiday-shortened week, as December gained 111 points to close at 68.35 cents.
Since falling over a cliff around the middle of June the market has been in the process of building a base, with December closing the last nine sessions in a fairly tight range of just 157 points, between 67.02 and 68.59 cents.
Speculators have clearly been the driving force behind the steep selloff that occurred between May 16 and June 26, when the December contract fell around 900 points, from 75 to 66 cents.
The CFTC Commitment of Traders report shows an almost perfect correlation between the selling of speculators and the market’s downtrend. In the six weeks between May 16 and June 27, speculators had sold a total of 8.04 million bales net, reducing their net long from 10.85 to 2.81 million bales and thereby forcing the market lower.
Initially some of the spec selling was absorbed by trade short covering in July, but once July open interest had melted away, the trade proved less willing buy December, which opened the door for the precipitous drop we saw in the second half of June.
However, with the spec net long down to just 2-3 million bales at the moment, not only did spec selling pressure subside, but the trade started to support the market at 66-67 cents. With July expiring near 75 cents, it is easy to see why December appears to have value at current levels, especially since the supply bottleneck will not be solved by early November.
We believe that the market overestimates how much cotton will be available for shipment in the 4th quarter. Last year average weekly shipments of Upland cotton amounted to just 173k running bales between October and December and two years ago they were even lower at only 103k running bales.
This season inventories will be about as low as we have ever seen them in the US and we are therefore not optimistic that the weekly shipment rate will reach an average of 200k in the 4th quarter. A lot more than that is needed to satisfy all the early commitments already on the books to domestic and foreign mills and for this reason we feel that December will remain well supported and that the Dec/March inversion will expand.
West Texas got another round of beneficial rains over the holiday weekend, although some acres were knocked out by hail. On balance the Texas crop seems to be improving though, which is why the market came under pressure earlier in the week.
So where do we go from here? We feel that the onslaught of spec selling is over for now and that the trade isn’t going to sell the market in the mid-60s either. There are simply too many early commitments on the books and with the crop being drawn out and slightly behind schedule we don’t expect any supply pressure until early 2018.
This should allow the current base building to continue and eventually lead to a bounce into the 70-72 cents area, where we would expect solid resistance unless a crop problem were to develop.
As stated last week, the market needs to first get past the bottleneck in the 4th quarter before it can apply supply pressure later in the season. For this reason we still like the long Dec/short March trade, which should work regardless of the crop size. If the crop is big, then March will come under greater pressure than Dec, which forces the inversion to increase, and if the crop falls short, then Dec will race away from the back months.
Directionally the market will probably remain in a sideways trend between 66-71 cents for now, waiting to see how the US and global supply/demand situation is shaping up over the coming months.
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